Chapter 13 Bankruptcy

Keep Your Property & Repay Debts Over Time

Save your home and car

Kathleen Michon, Attorney and Stephen Elias, Attorney

May 2014, 12th Edition

Are you considering Chapter 13 bankruptcy? Use this plain-English guide to decide if Chapter 13 is right for you and to learn how to keep valuable property and discharge your unsecured debts. This book will help you:

determine if you qualify for Chapter 13

find out if you can reduce your car loan balance, or the balance on other secured debts

Book

Wipe out debt - and save your house

When you file for Chapter 13 bankruptcy, you can wipe out some of your debt and pay off the rest over time with a replayment plan approved by the bankruptcy court. You may be able to:

avoid foreclosure

stop car repossession

reduce car loan debt

stop most debt collectors, and

remove junior liens from your home.

Here, you'll find clear explanations of the Chapter 13 process and worksheets to help you:

consider alternatives to bankruptcy

decide if Chapter 13 is your best option

determine if you qualify for Chapter 13

estimate your monthly plan repayment

find and work effectively with an excellent lawyer, and

rebuild your credit after bankruptcy.

This revised edition includes all the latest changes in bankruptcy law, including updated 50-state exemption tables, and important U.S. Supreme Court decisions.

If you are considering or have decided to file Chapter 13 bankruptcy, Nolo’s Chapter 13 Bankruptcy is the essential guide you need to understand the procedures and law.

Please note: This book does not cover business bankruptcies, farm reorganizations, or Chapter 7 personal bankruptcy. For Chapter 7 bankruptcy, see Nolo's How to File for Chapter 7 Bankruptcy.

Updated by Patricia Dzikowski, a practicing bankruptcy lawyer in Florida for 30 years. Patricia served as a panel bankruptcy trustee for more than 15 years, having administered more than 18,000 Chapter 7 cases. She has also served by appointment as a Chapter 11 Trustee, Chapter 11 Examiner, and the in-country (U. S.) trustee in a proceeding ancillary to a foreign bankruptcy case. Patricia has authored numerous articles on bankruptcy, consumer finance, debt resolution, and other consumer law topics on Nolo.com as well as for other websites in the Nolo network. Patricia is a graduate of the University of Miami Law School (JD) and also has a Master’s degree in Business Administration (MBA) and an undergraduate degree (BA) in Politics.

“An excellent book that can guide you through the process.”-Forbes

“This is the best book going if you choose to file alone or if you want background on the Chapter 13 process.”-Attorney Gary Klein, Co-Author of Consumer Bankruptcy Law and Practice

Prior to joining Nolo, Kathleen was the Directing Attorney of Public Counsel's Consumer Rights Project, represented inmates on death row, mediated cases in Small Claims Court, and arbitrated lemon law cases for the Better Business Bureau. Kathleen received a B.A. from Yale University and a law degree from Northwestern University School of Law.

Chances are good that you’ve picked up this book because your debts have become over­whelming. Maybe you are facing foreclosure on your home, repossession of your car, or constant letters and phone calls from debt collectors. Or perhaps, you’ve realized that your debts have grown far beyond your ability to repay them, and you’re wondering if there’s anything you can do to get control of your finances.

Chapter 13 bankruptcy could be the best way to resolve your debt problems. When you file for Chapter 13, you agree to repay all or a portion of your debts over time, under the supervision of the bankruptcy court. Chapter 13 allows you to keep your property while using your anticipated income to repay some or all of your debts.

This book opens up the world of Chapter 13 to any­one who wants to get a good idea of how Chapter 13 works and what it can do for you. The book stops short of giving you all the forms and instructions you would need to do your own Chapter 13 bankruptcy. That’s because we believe that very few people are able to successfully carry out this task without attorney representation. (See “Do You Need a Lawyer?” below.)

This chapter gets you started with an overview of Chapter 13 bankruptcy. It also explains other types of bankruptcy relief (including Chapter 7 bankruptcy) and options for dealing with your debts outside of bankruptcy.

Online Companion Page: Get Legal Updates and More at Nolo.com

You can find the online companion page to this book at:

www.nolo.com/back-of-book/CHB.html

There you will find important updates to the law, podcasts, Nolo’s Bankruptcy, Debt and Foreclosure Blog, and links to hundreds of online articles on bankruptcy, as well as on debt, credit, and foreclosure.

An Overview of Chapter 13 Bankruptcy

Chapter 13 can be a good solution for people who need time to pay off certain debts and who have enough income to meet the Chapter 13 requirements. In Chapter 13, you get to keep all of your property, regardless of its value. However, you will have to pay your unsecured creditors (those to whom you owe credit card debts, medical debts, and most court judgments, for example) at least as much as they would have received had you filed for Chapter 7 bankruptcy.

Chapter 13 has many benefits (discussed below in “Reasons to Choose Chapter 13”), but some of the most powerful involve your home. Chapter 13 bankruptcy allows you to catch up on mortgage arrears through your plan, so you can avoid foreclosure. (See Ch. 8.) And if you have second mortgages that are no longer secured by the equity in your property, you can strip them off. (See “Lien Stripping: Getting Rid of Home Loans Other Than Your First Mortgage,” below.)

Costs

Like everyone who files for Chapter 13 bankruptcy, you have to pay the filing fee of $281, due either when you file your initial bankruptcy paperwork or in four equal installments (with the court’s permission). You’ll also have to pay a fee—typically less than $100 total—to a credit counseling agency for prefiling credit counseling and postfiling budget counseling. If you decide to hire a lawyer to help you with your case, you can expect to pay an additional $3,000 or more in legal fees. You won’t have to come up with the entire fee all at once, but you will probably have to make a sizable initial payment and pay the rest over the course of your plan.

Do You Need a Lawyer?

For the vast majority of Chapter 13 filers, the answer is “yes.” It’s not that people can’t understand the ins and outs of Chapter 13 bankruptcy law (although at times the law can be quite complicated) or fill out the petition and accompanying schedules and forms (although again, some of those can get tricky); instead, the rub lies with the Chapter 13 repayment plan. Calculating plan payments has become quite difficult without the assistance of computer software, which is extremely expensive. In addition, it is not uncommon for the trustee or creditors to challenge or object to various aspects of your plan. You may have to argue against objections, negotiate with creditors, or modify your plan. In fact, most Chapter 13 plans need at least one modification along the way, even when prepared by an attorney. Experienced Chapter 13 bankruptcy lawyers have software to prepare your Chapter 13 plan and the expertise to handle objections to your plan and to modify it as your case proceeds.

We believe that most Chapter 13 filers benefit from legal representation, assuming the lawyer is honest and competent. Having said that, it’s still important to understand the Chapter 13 process, including options for dealing with debts and property, the possibility of reducing loan amounts (called cramdowns), and what you can expect to pay in your Chapter 13 plan. This book also helps you identify various tricky issues that might arise in your bankruptcy case.

It’s also helpful to run some preliminary numbers yourself to determine if Chapter 7 is an option for you or if funding a Chapter 13 plan is possible given your income and expenses. Chs. 4 and 5 take you through the means test (to see if you qualify for Chapter 7 bankruptcy) and provide step-by-step instructions on figuring out if you can fund a Chapter 13 plan.

To learn more about hiring and working with a bankruptcy lawyer, see Ch. 15.

Filing Your Papers

To begin a Chapter 13 bankruptcy, you fill out a packet of forms in which you disclose your property, debts, and economic transactions during the several years before you file. The official forms for Chapter 13 bankruptcy are the same as those for Chapter 7, with a few exceptions and additions.

In addition to the Chapter 7 forms, you must prepare or produce:

a form (Form 22C: Chapter 13 Statement of Current Monthly Income and Calculation of Commitment Period and Disposable Income) that determines whether your income is more or less than the median income in your state. This calculation determines how long your repayment plan must last. If your income is more than the median, your plan must usually last five years; if your income is less, you can propose a three-year plan. If your income is more than the median, you must also use this form to calculate how much disposable income you will have available to pay your unsecured creditors over the five-year period.

your Chapter 13 repayment plan, showing how you propose to pay certain mandatory debts (child support, tax arrearages, and so on) and, if you have sufficient income, at least a portion of your other unsecured debts over the three- to five-year period. (See Ch. 8.)

a certificate showing you have participated in a credit counseling program during the 180-day period before filing for bankruptcy (this require­ment is explained in Ch. 9). If the credit counseling agency comes up with a proposed repayment plan that would allow you to pay your debts outside of bankruptcy, you must submit this as well.

a certificate regarding child support obligations and your residence.

pay stubs from the 60-day period before you file, along with a cover sheet.

proof that you’ve filed your federal and state income tax returns for the previous four years.

a copy of your most recent IRS income tax return (or a transcript of that return).

The Repayment Plan

The repayment plan you submit with your other bankruptcy papers (or shortly after your initial filing) shows the judge how you will devote your disposable income to pay off all or some of your debt over the life of your plan.

Which Debts Must Be Repaid

Chapter 13 requires you to pay some of your debts in full within the life of the plan. You also must pay as much of your remaining debts as you can from the income you have available. Generally, you will have to be able to show, at the beginning of your case, that you are likely to have enough income to remain current on debts that secure collateral you want to keep (for example, a mortgage or car note) while fully paying off your back taxes, back child support owed to a child or an ex-spouse, and any mortgage and secured debt arrearages you owe. And, as explained in Ch. 3, your plan also has to allow for total payments to your unsecured creditors that are at least as much as they would have received had you filed for Chapter 7 bankruptcy. In other words, these payments must be at least equal to the value of your nonexempt property, less the costs, commissions, and fees that would have to be paid in order to sell that property.

Length of the Repayment Period

You must propose a repayment plan that lasts for either three or five years, depending on your income. As you’ll learn in Ch. 4, the bankruptcy law now imposes a number of requirements on filers whose average gross monthly income over the six months before they file for bankruptcy is more than the median income in their state. Among other things, these filers must propose a five-year repayment plan unless the plan proposes to pay 100% of the filer’s unsecured debt. In some courts, you may be allowed to propose a plan that is less than five years if you have no disposable income. Other courts require five years, regardless of your disposable income. (See Ch. 5.)

Filers whose average gross monthly income for the six-month period is less than the median usually have the choice of filing for either Chapter 7 or Chapter 13 bankruptcy. If they use Chapter 13, these filers may propose a three-year repayment plan and may use their actual expenses to calculate how much income they will have to devote to that plan.

Filers whose income is more than the median must use certain standard expense amounts set by the IRS—rather than their actual expenses—to calculate their plan payments. As a result, higher-income filers may have to devote more of their money, for a longer period of time, to repaying their debts.

To learn more about how to calculate your income, find out whether your income is above or below your state’s median, and figure out which expenses to use in calculating your plan payments, see Ch. 4.

Coming Up With a Plan the Judge Will Approve

You can’t proceed with a Chapter 13 bankruptcy unless a bankruptcy judge approves (confirms) your plan. As mentioned, some creditors are entitled to receive 100% of what you owe them, while others may receive a much smaller percentage or even nothing at all if you have insufficient disposable income left over after the mandatory debts are paid. For example, a Chapter 13 plan must propose that any child support you owe to a spouse or child (as opposed to a government agency) will be paid in full over the life of your plan; otherwise, the judge will not confirm it. On the other hand, the judge can confirm a plan that doesn’t repay any portion of your credit card debts if you won’t have any disposable income left after paying your child support obligations.

Tip

You may have more—or less—disposable income than you think. Chapter 13 requires you to commit your “pro­jected disposable income” to repaying your debts over the life of your plan. Initially, you calculate your projected disposable income by subtracting your allowable expenses from your average income during the six months before you file for bankruptcy. But if this does not give an accurate picture of your current income and expenses and given certain circumstances, you might be allowed to use your current income and expenses at the time you file, if those figures more accurately reflect your finances going forward. For more information on calculating your disposable income, see Ch. 5.

The Automatic Stay

When you file for Chapter 13 bankruptcy, the automatic stay goes into effect right away. The stay prevents most creditors from taking action to collect a debt against you or your property. So, for example, if a foreclosure sale of your home or a vehicle repossession is in the works, the stay stops the sale or repossession dead in its tracks. (However, the automatic stay doesn’t apply if you’ve had two previous bankruptcy cases dismissed in the past year.) The automatic stay is discussed in more detail in Ch. 2.

The Meeting of Creditors

Once you file your bankruptcy papers, the court will schedule a meeting of creditors (also called a 341 hearing) within 20 to 40 days after your filing date—and send notice of this meeting to you and the creditors listed in your bankruptcy papers. You (and your spouse if you have filed jointly) are required to attend. You’ll each need to bring two forms of identification—a picture ID and proof of your Social Security number.

The creditors’ meeting is conducted by the Chapter 13 bankruptcy trustee for your court. No judge is present, and the meeting is held outside of court, usually in the nearest federal building. Although the bankruptcy trustee is not a judge, you still have a duty to cooperate with the trustee as a condition of receiving a discharge.

A typical creditors’ meeting lasts less than 15 minutes. The trustee will briefly go over any questions raised by the information you entered in the forms. The trustee is likely to be most interested in the fairness and legality of your proposed repayment plan and your ability to make the payments you have proposed. (See Ch. 8 for more on Chapter 13 plans.) The trustee has a vested interest in helping you successfully navigate the Chapter 13 process because the trustee gets paid a percentage of all payments doled out under your plan.

The trustee will also require proof that you have filed your tax returns for the previous four years. If you can’t show that you filed returns, the trustee may continue the meeting to give you a chance to file these returns. Ultimately, you will not be allowed to proceed with a Chapter 13 bankruptcy unless and until you bring your tax filings up to date.

Resource

Help if you are behind in tax payments. If you owe taxes, you may benefit from professional help in the form of a tax attorney, an enrolled agent (licensed by the IRS), or a tax preparer. For more information on getting current on taxes and getting professional help, read Stand Up to the IRS, by Frederick W. Daily (Nolo).

When the trustee is finished asking questions, any creditors who show up will have a chance to question you. Secured creditors are most likely to attend, especially if they have an objection to the plan you have proposed. They may claim, for example, that your plan isn’t feasible, that you’re giving yourself too much time to pay your arrears on your car note or mortgage, or that your plan proposes to pay a secured debt at an amount that is less than the replacement value of the collateral.

An unsecured creditor who is scheduled to receive very little under your plan might show up, too, if that creditor thinks you should cut your living expenses and thereby increase your disposable income (the amount from which unsecured creditors are paid). This is more likely to happen if you are using your actual expenses to compute your disposable income (as filers whose income is less than the state median are allowed to do) instead of standard expense figures set by the IRS.

Come to the meeting prepared to negotiate with disgruntled creditors. If you agree to make changes to accommodate their objections, you must submit a modified plan. Keep in mind, though, that any decisions or agreements you make with creditors are not final at this point. The trustee or creditors will raise their objections (assuming they still have any after your negotiations) and then the bankruptcy judge (who is not at the meeting) will make a decision. As a general rule, the judge will go along with the trustee unless your lawyer can make a good case that the trustee (or creditor) is wrong.

The Confirmation Hearing

Chapter 13 bankruptcy requires at least one appearance by you or your attorney before a bankruptcy judge. (In some districts, the judge comes into the courtroom only if the trustee or a creditor objects to your plan, and you want the judge to rule on the objection.) At this “confirmation hearing,” which is usually held a few weeks after the creditors’ meeting, the judge either confirms (approves of) your proposed plan or sends you back to the drawing board for various reasons—usually because your plan doesn’t meet Chapter 13 requirements. (For example, a judge might reject your plan because you don’t have enough income to pay off your priority creditors in full while staying current on your secured debts, such as a car note or mortgage.)

You are entitled to amend your proposed plan until you get it right or the judge decides that it’s hopeless. Each amendment requires a new confirmation hearing and appropriate written notice to your creditors. (For more information on the confirmation hearing, see Ch. 10.) Once your plan is confirmed, it will govern your payments for the three- to five-year repayment period.

Possible Additional Court Appearances

If your plan is drafted correctly from the beginning, your confirmation hearing will probably be the only time the bankruptcy judge deals with your case. How­ever, additional appearances in court by you or your attorney may be necessary to:

confirm your repayment plan if you later amend it

value an asset, if your plan proposes to pay less for a car or other property than the creditor thinks it’s worth (this might happen if you try to cram down the debt to the item’s current value)

respond to requests by a creditor or the trustee to dismiss your case or amend your plan

respond to a creditor who opposes your right to discharge a particular debt (perhaps claiming that you incurred the debt through fraud)

discharge a type of debt that can be discharged only if the judge decides that it should be (for example, to discharge a student loan because of undue hardship)

eliminate a lien on your property that will survive your Chapter 13 bankruptcy unless the judge removes it, or

reaffirm a debt owed on a car or other secured property or that would otherwise not survive your bankruptcy.

Many of these procedures are explained in Ch. 11.

Making Your Payments Under the Plan

You are required to make your first payment under your proposed repayment plan within 30 days after you file for bankruptcy. If the bankruptcy court ultimately confirms your plan, your payment will be distributed to your creditors in accordance with the plan’s terms. If your Chapter 13 bankruptcy never gets off the ground, the trustee will return the money to you, less administrative expenses.

Once your plan is confirmed, you will make pay­ments, usually monthly, to the bankruptcy trustee, an official appointed to oversee your case. The trustee will usually require you to agree to an order that takes the payments directly out of your bank account or paycheck. The trustee uses your monthly payments to pay the creditors in accordance with the payment order contained in your plan. The trustee also collects a statutory fee (roughly 8% to 10% of the amount you will pay under your plan).

If you can show that you have a history of regular income spread out in uneven payments over the year—for example, quarterly royalty payments or predictable seasonal income fluctuations (for instance, if you do construction work in a location that has severe winters)—your plan may provide for payments when you typically earn income, rather than every month, but in most cases it will be monthly.

If Something Goes Wrong

Three to five years is a long time. What happens if you can’t make a payment or it becomes apparent—perhaps because of a change in your income or life circumstances—that you won’t be able to complete your plan? If you miss only a payment or two, you can usually arrange with the trustee to make up the difference. If you lose your income stream, however, and you definitely won’t be able to complete the plan, you can convert your bankruptcy to Chapter 7 (if that makes sense), obtain a “hardship” discharge from the court, or modify the plan. In many cases, Chapter 13 bankruptcies that don’t work out are dismissed entirely.

If your case is dismissed, you’ll owe your creditors the balances on your debts from before you filed your Chapter 13 case, less the payments you made, plus the interest that accrued while your case was open. See Chs. 12 and 13 for more on what happens if you are unable to complete your plan.

Personal Financial Management Counseling

Before you make your last plan payment, you’ll have to complete a personal financial management counseling course (called budget counseling)—and file an official form certifying that you did so—in order to get your discharge. This counseling covers basic budgeting, managing your money, and using credit responsibly. See Ch. 10 for more on this requirement.

After You Complete Your Plan

Once you complete your plan, certify that you’ve remained current on your child support or alimony obligations, and file proof that you’ve completed your personal financial management counseling, your remaining debts will be discharged, if they are the type of debts that can be discharged in Chapter 13. (See “Which Debts Are Discharged in Chapter 13 Bankruptcy,” below, for more information.) For instance, if you have $40,000 in credit card debt, and you pay off $10,000 through your repayment plan, the remaining $30,000 will be discharged once you complete the plan. However, you will still owe whatever is left of the debts that you can’t, by law, discharge in Chapter 13. Debts that you can’t discharge include child support, alimony, and student loans (unless you can show that repaying the loan would cause undue hardship); most types of debts—including credit card debts—are discharged.

Example: Karen owes $60,000 in credit card debts, $60,000 in student loans, and $2,000 in alimony. Karen pays off the alimony in full (as required by law) and 10% of her credit card debts and student loans. The remainder of the credit card debts will be discharged, but she will still owe the rest of her student loan debt ($54,000) unless she can convince the judge to order it discharged because of undue hardship.

Which Debts Are Discharged in Chapter 13 Bankruptcy

Not all debts are discharged in Chapter 13 bankruptcy. Of course, if you will repay all of your unsecured debts in full over the life of your plan, no discharge is necessary. But if your plan provides for less than full repayment of your unsecured debts, whatever you still owe may or may not be discharged.

Debts That Are Discharged

As a general rule, whatever you still owe on most credit card debts, medical bills, and lawyer bills is discharged, as are most court judgments and loans. Also, under bankruptcy law, debts you owe to an ex-spouse arising from a divorce or separation agreement that are not for support are discharged in Chapter 13 (but not in Chapter 7), as are debts incurred for the purpose of paying taxes.

Debts That Are Not Discharged

Debts that survive a Chapter 13 bankruptcy (unless you pay them in full during the life of your plan) include:

debts that you don’t list in your bankruptcy forms

court-imposed fines and restitution

back child support and alimony

student loans (unless you can show hardship)

recent back taxes

taxes for years in which you did not file a return, and

debts you owe because of a civil judgment arising out of your willful or malicious acts, or for personal injuries or death caused by your drunk driving.

Discharging Student Loans in Chapter 13 Bankruptcy: The Brunner Test

For the most part, student loans cannot be discharged in Chapter 13 bankruptcy. However, in rare circumstances, courts will discharge some or all of your student loans at the end of your Chapter 13 repayment period if paying them would cause undue hardship.

While there is some indication that courts are becoming more sympathetic to debtors saddled with student loan obligations and struggling to support their families, the bar to prove undue hardship (as opposed to ordinary hardship) is still set too high for most debtors.

Many courts use a three-factor test to determine if repaying your student loans would cause undue hardship, called the Brunner test (after a court case of the same name). Not all courts use this test, but even in those that don’t, it’s still difficult to discharge a student loan.

Under the Brunner test, a bankruptcy court looks at the following three factors to determine if repayment of your student loans would cause an undue hardship:

Based upon your current income and expenses, you cannot maintain a minimal standard of living for yourself and your dependents if you are forced to repay your loans.

Your current financial situation is likely to continue for a big part of the repayment period.

You have made a good-faith effort to repay your student loans.

Debts That Are Not Discharged If the Creditor Successfully Objects

Some types of debts will survive your bankruptcy only if the creditor files a motion in court to prove that the debt shouldn’t be discharged. For example, if a creditor successfully objects to a debt arising from your fraudulent actions or recent credit card charges for luxuries, those debts will be waiting for you after your bankruptcy, unless you managed to pay them all off during your repayment plan.

Chapter 13 Bankruptcy and Foreclosure

If you are behind in your mortgage payments or facing foreclosure, Chapter 13 bankruptcy might be able to help you keep your home. It can do this by allowing you to temporarily (or permanently) stop the foreclosure, catch up on back mortgage payments through your plan, get rid of certain junior liens thus freeing up more money to pay your first mortgage, and perhaps work out a foreclosure alternative with your lender through a bankruptcy foreclosure mediation program.

The Automatic Stay Can Stop a Foreclosure

If you are facing foreclosure, in most situations filing a Chapter 13 bankruptcy will immediately stop the foreclosure. There is an exception, however, if you filed bankruptcy within the previous two years and in that bankruptcy the court lifted the stay and allowed your lender to proceed with the foreclosure. (See Ch. 2 for more on the automatic stay and home foreclosures.)

Catching Up on Mortgage Arrears Through Your Chapter 13 Plan

Chapter 13 bankruptcy allows you to include your past due mortgage debt in your Chapter 13 plan. This means you can pay the arrears back over the length of your plan. The same is true of past due HOA assessments—you can catch up through your plan. As long as you keep making your regular mortgage payments (and/or your ongoing HOA assessments) and your Chapter 13 plan payments, your lender cannot foreclose. Chapter 7 bankruptcy, on the other hand, does not provide a way to get current on mortgage arrears. For this reason, Chapter 13 bankruptcy is often the best avenue for saving your home if you are behind in your mortgage or HOA assessments.

Getting Rid of Second Mortgages, HELOCs, and Other Junior Liens

Chapter 13 bankruptcy has another helpful remedy—lien stripping. Lien stripping allows you to remove second mortgages, home equity lines of credit (HELOCs), and other junior liens from your home if they are wholly unsecured. (See “Lien Stripping: Getting Rid of Second Mortgages and Other Liens on Real Estate,” below, to learn what wholly unsecured means.) By getting rid of some or all these payments, a homeowner is often better positioned to afford the remaining mortgages.

Foreclosure Mediation Programs in Bankruptcy

Since the foreclosure crisis, an increasing number of bankruptcy courts have instituted programs to help debtors, particularly in Chapter 13, to resolve foreclosure issues with their lenders. These programs (often called “loss mitigation programs”) vary by district. Most involve some form of foreclosure mediation in which the homeowner and the lender meet in the presence of a neutral mediator and try to work out an alternative to foreclosure. Possible workouts might include a loan modification, short sale, or deed in lieu of foreclosure. Most of these bankruptcy court programs apply only to residential property. But a few also include income-producing residential property (rental property) and second homes.

Many states have instituted foreclosure mediation programs within their state court system. These programs are available to homeowners who are in foreclosure but haven’t filed for bankruptcy. Unfortunately, these mediation programs often don’t have good results. Bankruptcy court foreclosure mediation programs, on the other hand, appear to be having more success.

There are many reasons why mortgage holders may be inclined to negotiate with homeowners who have filed for bankruptcy.

Deficiency balances are discharged in bankruptcy. A deficiency occurs when the amount you owe on your home exceeds the value of the home. In many states, after foreclosing on your home, the mortgage lender can sue you for the deficiency (in some states the lender can get the deficiency judgment through the foreclosure itself without filing a separate lawsuit). But Chapter 7 and Chapter 13 bankruptcy discharges all mortgage deficiencies. Knowing this provides an incentive for the mortgage lender to avoid foreclosure.

Defending against lien stripping and cramdowns can get expensive. A Chapter 13 debtor may try to get rid of junior liens (called lien stripping) or reduce the amount of the mortgage on nonresidential properties (called cramdown). (See “Special Chapter 13 Features: Cramdowns and Lien Stripping,” below). Mortgage holders often challenge the value of the property subject to lien stripping and cramdown, or try to lift the automatic stay to continue with foreclosure. The attorneys’ fees incurred in these challenges can get expensive. Often, mortgage holders are better off using this money to participate in foreclosure mediation, where they have a better chance of working out a resolution that is favorable for them.

Advantages of Foreclosure Mediation for Homeowners

Loss mitigation options are often better for homeowners as well. A homeowner can negotiate for options that may not otherwise be available through the bankruptcy court, including a loan modification that reduces the principal, provides for a longer payment period, and/or lowers the interest rate. A rental property owner might get a lower payment than he or she would in a cramdown by negotiating a longer time to pay. And if the mediation doesn’t work out and the homeowner decides to surrender the property, he or she may be able to negotiate terms for the surrender, such as additional time in the residence or a cash payment to help with relocation expenses.

Special Chapter 13 Features: Cramdowns and Lien Stripping

In Chapter 13 bankruptcy, you may be able to reduce the amount of a secured loan (for example, your car loan) to the actual value of the property; this is called a cramdown. And you might be able to get rid of second or third mortgages, HELOCs, or home equity loans if they are no longer secured by the equity in your home. This is called lien stripping.

Although these provisions are powerful, they don’t apply to the first mortgage of your residential real property. Some people believe they can “modify” the first mortgage on their home through bankruptcy. For the most part, this is a myth, although there are a few exceptions, such as for vacation and rental properties.

Caution

You lose the benefit of cramdown or lien stripping if your case is dismissed or converted to Chapter 7. Loan reductions or lien eliminations you get through cramdown or lien stripping are only good if you complete all of your payments under the Chapter 13 plan (or under a Chapter 11 bankruptcy). If your case is dismissed or converted to a Chapter 7, the secured creditors get their full lien amounts back, less any amounts you have paid through your plan.

Tip

You may be able to modify your mortgage through nonbankruptcy avenues. Although you can’t modify a first mortgage on a residential home through bankruptcy, you may be able to negotiate with your lender directly to reduce your interest rate, payments, or more. Or, you might be able to take advantage of government programs designed to help homeowners modify their mortgages. For more information, check out Nolo’s Foreclosure section at www.nolo.com or get Your Foreclosure Survival Guide, by Stephen Elias (Nolo).

Cramdowns: Reducing Secured Loans to the Value of the Collateral

If the amount you owe on a secured loan is more than the value of the collateral (the collateral is the property you pledge to guarantee payment of the loan), you may be able to take advantage of Chapter 13 provisions that result in what is commonly known as a cramdown. When you cram down a loan, you reduce the amount owed to equal the value of the collateral—and this happens without having to get the lender’s agreement.

Property That Is Eligible for Cramdown

You can only use a cramdown on loans secured by certain types of property. Significantly, you cannot cram down mortgages on your personal residence. But you may be able to use it on a mobile home mortgage or a mortgage for a multiunit building if you live in one of the units. Mortgages on your investment properties, such as rental property, a second home, or commercial property, are eligible. A cramdown is also available, subject to certain limitations, for car loans and other personal property loans.

Car loans. Cramdowns are often used for car loans. There are a few restrictions to keep in mind, however. For cars, in order to cram down the loan, one of the following must apply:

You incurred the debt at least 910 days before you filed for bankruptcy.

The loan is not a purchase money loan (that is, you secured the debt with a car you already owned, not a car you bought with the loan).

The car secured by the loan is not a personal vehicle (that is, you bought it for your business).

Other personal property loans. You may cram down debts for personal property (other than motor vehicles) only if you took out the loan at least a year before you filed for bankruptcy, or if the loan was not used to purchase the property that you pledged to secure repayment (that is, you owned the property before you took out the loan).

Real estate loans. You may be able to cram down mortgages secured by the following types of properties:

multiunit buildings (even if you live in one of the units)

vacation or rental homes

buildings or lots adjacent to your home that are not likely to be considered part of your residence, such as farmland

mobile homes (these are considered to be personal property), and

property that is not your residence.

How Cramdown Works

In bankruptcy, when a loan is undersecured (which means the amount you owe is greater than the value of the property pledged to secure repayment), the debt can be broken down into secured and unsecured portions. The amount equal to the value of the property is the secured portion and any amount over the value of the property is unsecured.

The first step in a cramdown is coming up with an accurate value for the property. While some courts may allow you to value your property through the plan, most courts require you to file a separate motion to value the property. You present your proof of value, such as an appraisal, and the creditor is provided with an opportunity to present its own valuation. If the values are not the same and you are unable to reach a compromise with the secured creditor, the court will hold an evidentiary hearing. You and the creditor bring your appraisers to testify, and the bankruptcy judge makes a decision.

Once the judge determines the value (and thereby the amounts of the secured and unsecured claims), in most cases, you must pay the entire amount of the secured portion through your plan, with interest. The appropriate interest is often also determined as part of your motion and is generally set at prime plus one to three points. For example, if the prime rate is 3.25%, an appropriate interest rate may be between 4.25% and 6.25%.

Cramming Down Negative Equity in the 9th Circuit

If you bought a car within 910 days of your bankruptcy filing (which means your loan is ineligible for cramdown), you might be able to cram down part of the loan if you traded in a car to buy the new car. You can only do this in the 9th Circuit (all other Circuits have rejected this interpretation of the law). Here’s how it works:

If, when you purchase a car, you trade in a car that is underwater (you owe more on the car than the car is currently worth), the lender often adds the difference between the trade-in value of your car and the remaining balance on the loan to your new car loan. For example, say your old car is worth $5,000 but you still owe $8,000 on the car loan. The lender for your current car purchase takes your old car as a trade-in, and adds $3,000 ($8,000 balance on loan minus the $5,000 value of car) to your new car loan. This amount is called negative equity.

In the 9th Circuit, if you file for bankruptcy, you can treat the $3,000 as unsecured debt, even if you bought the second car within 910 days of your bankruptcy filing. (In re Penrod, 611 F.3d 1158 (9th Cir. 2010).)

The unsecured portion of the claim is lumped in with your other unsecured debts. Because of the way unsecured debt is treated in a Chapter 13 bankruptcy, many bankruptcy filers pay pennies on the dollar on the unsecured portion.

Here’s an example of how this works:

You owe $20,000 on a car you bought three years ago. The car is now worth $15,000 (which means only $15,000 of the car loan is secured by the property). You can cram down the loan to $15,000 and pay this amount through your Chapter 13 plan. The remaining amount—$5,000—will be added to your unsecured debt and treated like all of your other unsecured debt.

Determining the Value of the Property

The appropriate methods of valuation depend on the type of property you are valuing.

Real estate and mobile homes. For real estate and mobile homes, use the current market value of the property. This is best accomplished through a formal appraisal—especially if you think the value may be contested by the secured creditor. If you don’t anticipate a fight, you may be able to use comparable sales in your area. This will be less expensive than paying for a full appraisal.

Personal property. For personal property, use the replacement value of the property. Replacement value is not the amount it would cost to replace the item with a new item. Rather it’s the amount a merchant could get for a used item of similar age and in a similar condition in a retail environment (as opposed to in a fire sale or auction). You can have the property appraised or use some other method to determine its replacement value.

For motor vehicles, you may be able to use an automotive industry guide, such as the Kelley Blue Book. Start with the retail value (rather than the wholesale value) and adjust that amount for the car’s condition and mileage. If the car lender disputes the figure, you may need to have the vehicle appraised.

Lien Stripping: Getting Rid of Second Mortgages and Other Liens on Real Estate

With lien stripping, you may be able to eliminate certain second mortgages, HELOCs, and other liens on your real property. Unlike cramdown, lien stripping can be used to reduce your secured debt payments on your personal residence as well as other real property. Like cramdown, it involves valuing the property. Here’s how it works:

If you have more than one mortgage on your property, you can ask the court to value the property and eliminate or “strip off” any mortgage that is determined to be wholly, or completely, unsecured. To figure out if a mortgage is completely unsecured, start with the value of the property and subtract the amount of any mortgages or liens that are more senior (meaning they must be paid off first) to the mortgage you are trying to strip. If the value of the property is less than the total amount of the senior mortgages and liens, then there is no equity left to secure the mortgage you are trying to strip, and it’s unsecured.

Lien stripping is generally not available for first mortgages. If, as is almost always the case, a first mortgage is the most senior lien on the property, it will never be completely unsecured. A second or third mortgage, or a HELOC, is usually eligible for lien stripping if it is wholly unsecured. If you have a homeowners’ or condominium association lien, however, you might not be able to strip it, even if it’s wholly unsecured. Whether you can depends on state law and the way the lien was created. (Consult with a local attorney to find out.)

Example: John and Ellen own a home currently worth $100,000. They have three mortgages—the first is $80,000, the second is $27,000, and the third is $50,000. The first mortgage is entirely secured because it is less than the value of the home. The second mortgage is partially secured since the value of the house less the first mortgage ($100,000 - $80,000 = $20,000) is enough to cover only part of the second mortgage. Since it is not completely unsecured, it cannot be stripped. John and Ellen have more luck with their third mortgage, which is completely unsecured. When you deduct the amount owed on the first two mortgages from the value of the house ($100,000 - $80,000 - $27,000 = -7,000), the result is less than zero. There is no equity left to provide security for the third mortgage. This means that John and Ellen can strip the entire $50,000 third mortgage.

Like cramdown, when a mortgage is stripped, the underlying debt becomes unsecured and is paid in your Chapter 13 plan along with your other unsecured creditors, such as credit cards and medical bills. These creditors usually receive only pennies on the dollar and sometimes less.

CAUTION

Lien stripping is not the same as lien avoidance. In Chapter 13 bankruptcy, you may also be able to “avoid” liens, or get rid of them, if the property is exempt. Although the end result may be the same, or similar, lien avoidance is different from lien stripping because it hinges on property exemptions. To learn more about lien avoidance, see Ch. 11.

Is Chapter 13 Right for You?

For most people, the two choices for bankruptcy relief are Chapter 7 and Chapter 13. In Chapter 7 bankruptcy, you immediately wipe out many debts, but in exchange you must give up any property you own that isn’t protected by state or federal exemption laws.

Some of you won’t have a choice between Chapter 7 and Chapter 13 bankruptcy; if you want to file for bankruptcy, you will have to use Chapter 13 and repay some of your debt. (See Ch. 4 to find out whether you’ll be limited to Chapter 13.) Likewise, if you don’t have a steady income, your only bankruptcy choice is Chapter 7. Many people who have a choice decide to file under Chapter 7, but there are some situations when Chapter 13 will be the better option.

Upper-Income Filers Must Use Chapter 13

If your average monthly income during the six months before you file for bankruptcy is higher than the median income for your state, you may not be able to use Chapter 7. If your average income is more than the median, you cannot file for Chapter 7 bankruptcy if your disposable income would allow you to pay your unsecured creditors at least $12,475 over a five-year period (about $208 a month). (See Ch. 4 for more on this “means” test.)

Reasons to Choose Chapter 7

Most people who have a choice traditionally have opted to file for Chapter 7 bankruptcy because it is relatively fast, effective, easy to file, and doesn’t require payments over time. It also doesn’t require you to be current on your income tax filings. In the typical situation, a case is opened and closed within three to four months, and the filer emerges debt free except for a mortgage, car payments, and certain types of debts that survive bankruptcy (such as student loans, recent taxes, and back child support).

If you have any secured debts, such as a mortgage or car note, Chapter 7 allows you to keep the collateral as long as you are current on your payments. However, if your equity in the collateral substantially exceeds the exemption available to you for that type of property, the trustee can sell the property, pay off the loan, pay you your exemption (if any), and pay the rest to your unsecured creditor. If you are behind on your payments, the creditor can come into the bankruptcy court and ask the judge for permission to repossess the car (or other personal property) or foreclose on your mortgage. As a general rule, however, most Chapter 7 filers are able to keep all their property, either because they don’t own much to begin with or because any equity they own is protected by an exemption.

Changes in the bankruptcy law in 2005 put a few obstacles in the way of Chapter 7 filers. Nevertheless, assuming you qualify, you likely will find it easier—and more effective—to file for Chapter 7 than to keep up with a long-term payment plan under Chapter 13. And if you do file for Chapter 13 and don’t keep up with your repayment plan, you will likely get no benefit from having engaged in the Chapter 13 process if you later convert to a Chapter 7 (unless the court lets you off the hook early for hardship reasons or you were able to bring car or mortgage payments current during the time you were in Chapter 13).

Example: Frank files for Chapter 13 bankruptcy. His five-year plan includes current payments on his mortgage, repayment of part of his $50,000 credit card debt, and payment in full of a $2,000 back child support debt. Frank remains current on his plan for three years and then loses his job. In that three-year period, Frank, through the Chapter 13 trustee, paid $12,000 on credit card debt as well as the child support debt.

If Frank converts his case to Chapter 7, he can discharge all of the remaining credit card debt. But had Frank filed Chapter 7 from the beginning, he could also have discharged the $12,000 that he already paid to the credit card companies under his Chapter 13 plan. If Frank decides to skip Chapter 7 and negotiate a repayment schedule for the remaining $38,000, he will at least have made a $12,000 dent in the original $50,000 debt by filing for Chapter 13.

The moral of the story is that you should file for Chapter 7 in the first place if:

You are eligible to use Chapter 7.

You have significant doubts about your ability to complete a Chapter 13 repayment plan.

None of the pressing reasons to use Chapter 13 are present in your case (see below).

For many people, the overriding reason to choose Chapter 7 is that they can do it themselves for little or no money (other than the filing fee), whereas they don’t feel comfortable handling their own Chapter 13 case and cannot afford to pay $3,000 or more in attorneys’ fees.

Reasons to Choose Chapter 13

Although Chapter 7 is easier and doesn’t require repay­ment, there are many good reasons why people who qualify for both types of bankruptcy choose Chapter 13 instead. Generally, Chapter 13 bankruptcy might make sense if you will have adequate, steady income to fund your plan for the appropriate period of time, and are in any of the following situations:

You are facing foreclosure on your home or your car is being repossessed, and you want to keep your property. Using Chapter 13, you can make up the missed payments over time and reinstate the original agreement. You generally cannot do this in Chapter 7 bankruptcy—instead, you’ll ultimately lose the property.

You owe more on a vacation or investment property than that property is worth, and you can reduce the mortgage to the value of the property in Chapter 13. (This is possible only if you are not using the real estate as your primary residence.) (See “Special Chapter 13 Features: Cramdowns and Lien Stripping,” above.)

You have more than one mortgage and are facing foreclosure because you can’t make all the payments. If your home’s value is less than or equal to what you owe on your first mortgage, you can use Chapter 13 to change the additional mortgages into unsecured debts—which don’t have to be repaid in full—and lower the amount of your monthly payments. (See “Special Chapter 13 Features: Cramdowns and Lien Stripping,” above.)

Your car is reliable and you want to keep it, but it’s worth far less than you owe. You can take advantage of Chapter 13 bankruptcy’s cramdown option (for cars purchased more than 2½ years before filing for bankruptcy) to keep the car by repaying its replacement value in equal payments over the life of your plan, rather than the full amount you owe on the contract. (See “Special Chapter 13 Features: Cramdowns and Lien Stripping,” above.).

You have a codebtor who will be protected under your Chapter 13 plan but who would not be protected if you used Chapter 7 (see Ch. 2).

You have a tax obligation, student loan, or another debt that cannot be discharged in bankruptcy, but can be paid off over time in a Chapter 13 plan.

You owe debts that can be discharged in a Chapter 13 bankruptcy but not in a Chapter 7 bankruptcy. For instance, debts incurred to pay taxes can’t be discharged in Chapter 7 but can be discharged in Chapter 13.

You want to use the Chapter 13 forum to sue one or more harassing creditors for violating state and federal antiharassment laws. For more information on these laws, see Solve Your Money Troubles: Debt, Credit & Bankruptcy, by Robin Leonard and Margaret Reiter (Nolo).

You have a business that you would have to close down in a Chapter 7 bankruptcy but can continue to operate in Chapter 13.

You have valuable personal property or real estate that you would lose in a Chapter 7 case, but could keep if you file for Chapter 13.

You have a sincere desire to repay your debts, but you need the protection of the bankruptcy court to do so.

Alternatives to Bankruptcy

By now, you should have a pretty good idea of what filing a Chapter 13 bankruptcy will involve—and what you can hope to get out of it. Before you decide whether a Chapter 13 or Chapter 7 bankruptcy is the right solution for your debt problems, however, you should consider some basic options outside of the bankruptcy system. Although bankruptcy is the only sensible remedy for some people with debt problems, an alternative course of action makes better sense for others. This section explores some of your other options.

Do Nothing

Surprisingly, the best approach for some people who are deeply in debt is to take no action at all. You can’t be thrown in jail for not paying your debts (with the exception of child support), and your creditors can’t collect money from you that you just don’t have.

Creditors Must Sue to Collect

Except for taxing agencies and student loan creditors, creditors must sue you in court and get a money judgment before they can go after your income and property. The big exception to this general rule is that a creditor can take collateral—foreclose on a house or repossess a car, for example—when you default on a debt that’s secured by that collateral. (Although in some states, mortgage servicers must file a lawsuit in order to foreclose on your house.)

Under the typical security agreement (a contract involving collateral), the creditor can repossess the property without first going to court. But the creditor will not be able to go after your other property and income for any “deficiency” (the difference between what you owe and what the repossessed property fetches at auction) without first going to court for a money judgment.

To secure a money judgment, a creditor must have you personally served with a summons and complaint. In most states, you will have 30 days to file a response in the court where you are being sued. If you don’t respond, the creditor can obtain a default judgment and seek to collect it from your income and property. If you do respond—and you are entitled to do so even if you think you owe the debt—the process will typically be set back several months until the court can schedule a trial where you can be heard. In most courts, you respond by filing a single document in which you deny everything in the creditor’s complaint (or, in some courts, admit or deny each of the allegations in the complaint).

Much of Your Property Is Protected

Even if creditors get money judgments against you, they can’t take away such essentials as:

basic clothing

ordinary household furnishings

personal effects

food

Social Security or SSI payments necessary for your support

unemployment benefits

public assistance

bank accounts with direct deposits from government benefit programs, and

75% of your wages (but more can be taken to pay child support judgments).

The general state exemptions described in Ch. 4 (and listed in Appendix A) apply whether or not you file for bankruptcy. Even creditors who get a money judgment against you can’t take these protected items. (However, neither the federal bankruptcy exemptions nor the state bankruptcy-only exemptions available in California and a few other states apply if a creditor sues you in state civil court.)

When You Are Judgment Proof

A judgment is good only if the person who has it—the judgment creditor—can seize income or property from the debtor. If you have no property or income that can be taken to pay the judgment, you are said to be “judgment proof.” For example, if your only income is from Social Security (which can be seized only by the IRS and federal student loan creditors) and all your property is exempt under your state’s exemption laws, your judgment creditor can’t take your income. Your life will continue as before, although one or more of your creditors may get pushy from time to time. While money judgments last a long time and can be renewed, this won’t make any difference unless your fortunes change for the better. If that happens, you might reconsider bankruptcy at that time.

If your creditors know that their chances of collect­ing judgments from you any time soon are slim, they probably won’t sue you in the first place. Instead, they’ll simply write off your debts and treat them as deductible business losses for income tax purposes. After some years have passed (usually between four and ten), the debt will become legally uncollectible, under state laws known as statutes of limitation.

These statutes of limitation won’t help you if the creditor sues or renews its judgment within the time limit, but most won’t. Lawsuits typically cost thousands of dollars in legal fees. If a creditor decides, on the basis of your economic profile, not to go to court at the present time, it is unlikely to seek a judgment down the line to extend its claims. In short, because creditors are reluctant to throw good money after bad, your poor economic circumstances might shield you from trouble.

CAUTION

Don’t restart the clock. The statute of limitations can be renewed if you revive an old debt by, for example, admitting that you owe it or making a payment. The specifics vary by state. As soon as you take the action necessary to revive the debt, the clock starts all over again. Savvy creditors are aware of this loophole and may try to trick you into reviving the debt so they can sue to collect it. Sometimes, it might be a good idea to try to repay a debt, particularly one to a local merchant with whom you wish to continue doing business. But unless you are planning to make good on the debt or try to negotiate a new payment schedule, you should avoid any admissions.

Stopping Debt Collector Harassment

Many people file for bankruptcy to stop their creditors from making harassing telephone calls and writing threatening letters. As explained above and in Ch. 2, the automatic stay stops most collection efforts as soon as you file for bankruptcy. However, you don’t have to start a bankruptcy case to get annoying creditors off your back. Federal law forbids collection agencies from threatening you, lying about what they c